Virtual Stock Portfolio Update: October 2005

October was a good month for the virtual stock portfolio.  The portfolio was up 8.7% compared to the NASDAQ's 1.5% loss thanks to some rebalancing I did last month as well as some paticularly good picks on the short side.  My short picks were up 9.0% and my longs we off just 0.3%.  I started the month about 18% net short on an beta adjusted basis, so the strong short performance is somewhat to be expected, but I was happy that my longs generally held up as well.

Year to date the portfolio is up 28.1% vs. a decline of  1.1% for the NASDAQ, which is a little bit better's than last year's 24.4% gain by the end of October.  I am not going to make any changes this month as most of the picks still have some decent room to improve, but I will probably have to do a bunch of changes next month.

Long Picks

Company: Microstrategy Ticker: MSTR
Sub-sector: Business Intelligence
Investment Thesis: I like the BI space in general and have been keeping my eye on Microstrategy.  This has recently been one of the cheaper stocks in the space, yet it also has one of the better product portfolios and market positions.  Businesses are still spending big bucks on BI and MSTR should be a big beneficiary.
Performance: Since 3/31/05: +31.3%,  Oct. vs. Sep.: 1.3%
Comments: Dodged a bullet this month on MSTR when they missed their Q3 numbers but not by enough to shake long term confidence dramatically.  While the stock got hit on the miss, there is so much of the float short that covering rapidly drove the stock price back up after the miss and allowed me to eek out a small gain.  I need to do some deep drilling to see if this will stay in the portfolio much past this month.

Company: FireOne Group Ticker: FPA.L
Sub-sector: Financial Services
Investment Thesis: FireOne operates an Internet payment service very similar to Neteller. It is used primarily by on-line gamblers to transfer money around.  I I added FireOne to the portfolio because I wanted to maintain overweight exposure to the these kind of Internet payments plays without putting all my eggs in one basket (Neteller). Now that I have closed out Neteller this will be sole exposure to Internet payments.  I am holding on to FPA because it trades at a discount to Neteller.
Performance: Since 7/31/05: -8.7%,  Oct. vs Sep.: -8.7%
Comments: Worst performer of the month thanks to the continued implosion of valuations in the online gambling space.  Did not do as poorly as some others, but still not great.  I will hold this month as I expect valuations to recover a bit as people realize that gambling is not going away.

Company: Actuate Ticker: ACTU
Sub-sector: Business Intelligence
Investment Thesis: Acutate is a business intelligence company with a particular focus on enterprise reporting.  I had a long postion in ACTU in 2004 and lost money on it, but I think the stock is back on the upswing now thanks to an improved product line and focus.   ACTU trades at a healthy discount to rest of the BI group (kind of like SPSS did at one point) and every penny of upside in its EPS could really move the stock.
Performance: Since 9/30/05: +13.8%  Oct. vs. Sep.: +13.8%
Comments: Very good performance in a tough market for long picks thanks primarily to a nice upward surprise on Q3 earnings.  Q4 numbers look very makable as well.  This stock is easily headed above $3/share.

Company: OpenText Ticker: OTEX
Sub-sector: Content Management
Investment Thesis: OpenText is a content management company that went on an acquisition binge in 2003 and 2004.  The stock suffered from all the M&A related charges and fallout but managment now claims that they are going to resolutely focus on EPS growth.  OTEX trades at a healthy discount to the rest of the content management group and has a broad product portfolio.  Integration snafus could trip them up, but the low multiple on the stock should limit any potential damage.
Performance: Since 9/30/05: -2.0  Oct. vs. Sep.: -2.0%
Comments: Not a great first month in the portfolio, but given its strong September the stock was likely to take a breather.  I still like this stock over the next few months.

Company: Cryptologic Ticker: CRYP
Sub-sector: Gaming Software
Investment Thesis: Cryptologic is a provider of gambling software to online casinos and poker rooms.  They license their software to numerous companies in return for a cut of the take.  About 70% of their revenues are from casino related software sales and about 30% from poker related sales.  Since they are a technology provider and not an operator they actually are listed in the US and do not appear to be in danger of violating any online gambling laws.
Performance: Since 9/30/05: -4.4%  Oct. vs. Sep.: -4.4%
Comments: Caught up in the turmoil affecting the online poker stocks even though 70% of its revenues are casino related.  I like the stock even more at these valuations.   I have no idea why people are now trading the online gambling stocks at 30-40% discounts to the mature casino companies despite the fact that the online stocks have about 2X the margins and 4X the growth.  Reason should ultimately prevail here.

Pair Trades
Long: Party Gaming Ticker: PRTY.L
Short: SportingBet Ticker: SBT.L
Sub-sector: Online Gambling
Investment Thesis: Party gaming is the largest online gambling company in the world with an exclusive focus on poker.  Party went public this summer at 100p and got up to 140p before getting creamed when it talked down its revenue growth prospects on its 1st earnings call.  The stock is now below its IPO issue price and at this level it is not only at 12X earnings, but 12.4X cashflow (of $500M/year) for a cash flow yield of over 8%.  In comparison to Party, SportingBet is trading at a substantial premium (21X vs. 12X) even though much of the excitement surrounding SBT has to do with its acquisition of Paradise Poker (the #5 poker room).  It will be tough for SBT to sustain the premium to Party given Party's superior margins, cash flow and growth rates.  With the paired trade the legal risk facing the sector is minimized because both would likely suffer equally from any legal action.  Up until now these kinds of trades didn't make sense because all the names traded pretty much in line with each other, but with Party's somewhat unwarranted implosion this is a perfect opportunity to put on such a trade.
Performance: Since 9/30/05: +3.0%  Oct. vs. Sep.: +3.0%
Comments: This trade started out disasterously in the beginning of the month, but cooler heads prevailed and the inevitable multiple compression looks like it is now underway.  After seeing Party's Q3 update, I have no idea how SBT can sustain a premium PE.

Short Picks

Company: Wave Systems Ticker: WAVX
Sub-sector: Security
Investment Thesis: I first encountered Wave when I wrote my initial analyst report on Wall Street in the mid-1990s. Wave has remained in business largely by claiming that it is developing revolutionary security technologies, kind of like a bio-tech company that never gets out of trials. With a grand total of $1.4M in revenues over the last 3.5 years, a $4M/quarter cash burn rate and only $4M or so in the bank, a day of reckoning is fast approaching.
Performance: Since 10/1/04: +5.5%  Oct. vs. Sep.: 7.5%
Comments: The stock got yet another delisting notice at the end of the month and with cash running out (yet again) in the next month or so, shareholders will undoubtedly be looking at yet another highly dilutive PIPE transaction.   It took a 24% discount to market on non-restricted fully registered shares to get the last PIPE done and yet the stock is trading almost 10% below that issue price less than 3 months after that deal.  It will be interesting to see what kind of terms they have to offer to get this one done.   The funny thing is, I could get wacked on this short if revenues for Q2 are more than a couple hundred K above last quarter's even though the company will still be losing millions as the hard core retail investors holding this stock inexplicably don't seem to be focused on the bottom line.  It's amazing to me that the board hasn't fired the obviously inept management team yet, but until they do that's good news for my short.

Company: Citadel Security Software Ticker: CDSS
Sub-sector: Security
Investment Thesis: Citadel offers a subscription service to help companies spot security vulnerabilities.  It's a good idea, but a lot of other companies including a number of private companies offer the same service.  Lately Citadel's business has been falling off a cliff.  They are buring cash to the tune of $5M/quarter and yet the management team hasn't done any major cost cutting.  As a VC, I can tell you first hand that it is incredibly difficult to turn around this kind of situation even if you get some product momentum.  I haven't seen a single company in this kind of shape pull it out.
Performance: Since 9/30/05: 28.3%    Oct. vs. Sep.: 28.3%
Comments: Better late than never I guess.  The stock traded off strongly in October as the remaining retail investors realized that the company was approaching "the wall" at 100mph.  The company postponed judgement day by doing a financing with a former board member which essentially paid off the bank debt (which was in default) and provided enough cash to make another payroll cycle.  This company needs to close a major (highly dilutive) financing or be sold by the end of the month.

Company: Emerge Interactive Ticker: EMRG
Sub-sector: Vertical Applications
Investment Thesis: Do you need software to help trade and manage cattle?  Apparently not many other people do either, otherwise EMRG wouldn't have generated only $335K in revenues last quarter.  With cash finally running out after $205M in losses this company should be headed for the slaughterhouse shortly.
Performance: Since 9/30/05: 30.8% Sep. vs. Aug.: 30.8%
Comments: Stock traded down sharply on no real news which seems to indicate that there are no buyers left.  I feel like it would be greedy to hold this stock another month, but I don't see any reason why things will get better.

Company: Entrust  Ticker:  ENTU
Sub-sector: Security
Investment Thesis: Entrust started out providing Certificate Authority software for use in public key encryption and now has a broader line of identify management products.  I know them from my days covering the security sector on Wall Street.  They seem to disappoint at least once a year and given that the stock has now fully recovered from their last dissapointment they should be due again.  It doesn't help that most of the major software players, including IBM, Oracle and CA, have made their own identity management acquisitions in the past 18 months either.
Performance: Since 9/30/05: +20.5% Oct. vs. Sep.: +20.5%
Comments: A good first month in the portfolio.  Hit their quarter but guided down leading to a sell-off.  Seems as though investors are realizing that growth won't be particularly easy now that they face competition from the big boys.